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An Intrinsic Calculation For Sun Hung Kai Properties Limited (HKG:16) Suggests It's 23% Undervalued
In this article we are going to estimate the intrinsic value of Sun Hung Kai Properties Limited (HKG:16) by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
See our latest analysis for Sun Hung Kai Properties
The calculation
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Levered FCF (HK$, Millions) | HK$19.9b | HK$23.8b | HK$18.9b | HK$20.9b | HK$22.8b | HK$22.8b | HK$22.9b | HK$23.1b | HK$23.4b | HK$23.6b |
Growth Rate Estimate Source | Analyst x4 | Analyst x4 | Analyst x3 | Analyst x1 | Analyst x1 | Est @ 0.1% | Est @ 0.51% | Est @ 0.8% | Est @ 1.01% | Est @ 1.15% |
Present Value (HK$, Millions) Discounted @ 7.5% | HK$18.5k | HK$20.6k | HK$15.2k | HK$15.6k | HK$15.9k | HK$14.8k | HK$13.8k | HK$12.9k | HK$12.1k | HK$11.4k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$151b
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 1.5%. We discount the terminal cash flows to today's value at a cost of equity of 7.5%.
Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = HK$24b× (1 + 1.5%) ÷ (7.5%– 1.5%) = HK$395b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= HK$395b÷ ( 1 + 7.5%)10= HK$191b
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is HK$342b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of HK$91.0, the company appears a touch undervalued at a 23% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
The assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Sun Hung Kai Properties as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 7.5%, which is based on a levered beta of 1.253. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Moving On:
Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For Sun Hung Kai Properties, we've compiled three essential items you should look at:
- Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Sun Hung Kai Properties , and understanding it should be part of your investment process.
- Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for 16's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SEHK every day. If you want to find the calculation for other stocks just search here.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
About SEHK:16
Sun Hung Kai Properties
Develops and invests in properties for sale and rent in Hong Kong, Mainland China, and internationally.
Good value with adequate balance sheet.